Managerial Economics

Managerial Economics is the economics of today. Modern management demands it. In the
last quarter of the century we have witnessed an evergrowing report between economic theorists and
managerial economists, based on realization of their mutual interdependence. That, in fact, is the
spirit behind writing this book.
Managerial economics is concerned with discussion making at the managerial level. The
book presents the alternative theories of firm behaviour, decision making problems and different
approaches to arrive at the most appropriate answers to such problems. This is accomplished through
a brief and logical discussion on the various relevant concepts and techniques and through hypothetical
examples, to illustrate the decision-making process. At the end of each chapter, small caselets are
incorporated for students to work on in order to ascertain their understanding of the material presented
in the corresponding chapter. The approach adopted is a good mix of verbal language, geometry and
algebra. While the emphasis is on theory and normative answers numerous practical examples are
cited and integrated in the material presented in the text.
Managerial economics draws heavily from micro-economics, econometrics and operations
research. Accordingly, the book borrows the relevant concepts from all these disciplines and also
some from macro-economics. The approach of the text is to first pose problems relating to the
decision making process and then seek answers. The book does not give the detailed exposition of
micro-economics or of any other disciplines, rather it accords a synthesis of all the relevant aspects
of the related subjects to arrive for decision-making problems faced by the firms.
The book is written primarily for students pursuing post-graduate courses in management. It
should also be useful to those who are doing M. Com and CA. Since many instructors of economics
emphasize applications the book could serve as good reference book for those students who are
doing MA in Economics as well.

Chapter 1 Price: 2.99

For most purposes economics can be divided into two broad categories, microeconomics and
macroeconomics. Macroeconomics as the name suggests is the study of the overall economy and its
aggregates such as Gross National Product, Inflation, Unemployment, Exports, Imports, and Taxation
Policy, etc.

Chapter 2 Price: 2.99

The firm is an organization that produces a good or service for sale and it plays a central role in
theory and practice of Managerial Economics. In contrast to non-profit institutions like the ‘Ford
Foundation’, most firms attempt to make a profit. There are thousands of firms in India producing
large amount of goods and services; the rest are produced by the government and non-profit institutions.
It is obvious that a lot of activities of the Indian economy revolve around firms. One of the crucial
determinants of a firm’s behaviour is the state of technology. Technology imposes a limit on how
much a firm can produce. It is the sum total of society’s pool of knowledge concerning the industrial
and agricultural arts. Production is any activity that transforms inputs into output and is applicable not
only to the production of goods like steel and automobiles, but also to production of services like
banking and insurance. The firm changes hired inputs into saleable output. An input is defined as
anything that the firm uses in its production process. Most firms require a wide array of inputs. For
example, some of the inputs used by major steel firms like SAIL or TISCO are iron ore, coal, oxygen,
skilled labour of various types, the services of blast furnaces, electric furnaces, and rolling mills as
well as the services of the people managing the companies. To give another example, the inputs in
production and sale of “chaat” by a street vendor are all the ingredients that go into making of the
“chaat”, i.e., the stove, the “carrier”, and the services of the vendor.

Chapter 3 Price: 2.99

The manager needs various techniques to assist him in making decisions that will ultimately maximize
the value of the firm. These techniques and tools are quantitative in nature. The introduction of some
commonly used tools used in managerial decision-making becomes imperative.
In this unit, we are going to discuss some basic techniques which would be helpful in
understanding the concept of managerial economics, in turn helping us to apply these techniques as
and when required.

Chapter 4 Price: 2.99

After having discussed the determination of rent of land, wages of labour and interest on capital, we
now pass on to the study of profits which are said to be the reward for enterprise, the fourth factor
of production. No doubt profits are associated with an entrepreneur and his functions but the economists
from time to time have expressed diverse and conflicting views about the nature, origin and role of
profits. Till today, there is no complete agreement among economists about the true nature and origin
of profits. As a matter of fact, there has been perhaps no topic in the whole economic theory which
has been in such a confused and tangled state as the theory of profits.

Chapter 5 Price: 2.99

Having discussed the demand side of the price theory, we
now proceed to discuss the supply side. Supply side relates
to the production of goods and services. Production of goods
depends on the cost of production, which in turn depends on
the prices of inputs or the factors of production. Cost of
production is determined by the physical relationship between
inputs and outputs. In the theory of production, we largely
discuss the relation between inputs and output.

Chapter 6 Price: 2.99

Organization of business in modern times assumes several forms,e.g., sole proprietorship, individual
entrepreneur or one-man business, partnership, joint-stock companies, industrial combination,
co-operative enterprises and state enterprises

Chapter 7 Price: 2.99

An economy supports population, but population too, in a sense,
supports the economy. It is the aim of an economy to supply
people’s wants for goods and services, but the people too make
an important contribution to the productive capacity of an
economy. A study of population trends, therefore, is of great
importance in the study of economic theory.
There are two well-known theories of population: The
Malthusian Theory and Optimum Theory. We shall now briefly
discuss them here.

Chapter 8 Price: 2.99

Under capitalism, price mechanism solves the central problems of the economy. Further, price of
any commodity or economic service is determined by the interaction of demand and supply. It is
important to understand precisely what demand and supply are, as they play an important role in the
determination of price of a commodity.
The modern theory of demand rests on the structure built by Alfred Marshall (1842-1924).
He taught at Cambridge University and through his book ‘
Principles of Economics’, influenced the thinking of the British and American economists.

Chapter 9 Price: 2.99

The indifference curve analysis was originally developed to study the consumer behaviour. Now, it
has wide applications in explaining different economic phenomena. The indifference curve technique
has also been fruitfully applied in analyzing various economic problems. The applications of the
indifference curve analysis in explaining economic phenomena are discussed in this chapter. More
important applications are explained in the next chapter.

Chapter 10 Price: 2.99

The concept of consumer surplus occupies an important place in economic theory, particularly in
consumer theory of demand, taxation policy of the government and welfare economics. Many welfare
propositions can be derived by using a theoretical structure provided by consumer surplus. Marshall,
his disciple A. C. Pigou and many other neo-classical economists did use it for deriving various
welfare propositions and policy prescriptions in economics. The concept was originally developed by
a French economist Arsene Jules Dupit in 1844, who sought to measure the consumer surplus that
would accrue to the people consequent upon the construction of a bridge across a river. It was
modified and made popular by Alfred Marshall. Recognising the importance of the concept in economic
analysis,Hicks explained it with the help of indifference curves approach.

Chapter 11 Price: 2.99

The theory of demand given by
Marshall
(Marshall’s utility analysis) as well as by Hicks-Allen
(indifference curve analysis) provides psychological explanation of the consumer’s behaviour by
applying introspective method. Both the theories are based on introspection and subjectivity. They
derive laws about consumer’s demand from how he would react psychologically to certain hypothetical
changes in price and income. These theories require a lot of information from the consumer, which
a consumer is generally incapable of providing. For example, the construction of indifference map
under indifference curve approach requires that a consumer must be able to state his indifference as
well as his preferences among all possible combinations of commodities precisely and rationally. As
preferences cannot be observed, the indifference technique remains non-operational. In the absence
of knowledge of indifference curves, the preference indifference approach cannot be used to analyze
a consumer’s choice problem.

Chapter 12 Price: 2.99

The scale of production has an important bearing on
the cost of production. It is the manufacturers’
common experience that larger the scale of
production, the lower generally is the average cost
of production. That is why the entrepreneur is tempted
to enlarge the scale of production so that he may
benefit from the resulting economies of scale. These
economies are broadly speaking of two types: Internal
economies and external economies, which we shall
presently consider in some detail. But before we do
that, we shall dwell on the economies and
diseconomies of large-scale production.

Chapter 14 Price: 2.99

We shall first study the laws of return, which are different aspects of one law, viz., the law of
variable proportions, and then returns to scale and in the next chapter equal product curves.
There are three laws of returns known to economists, the laws of diminishing, increasing and
constant return. “There is said to be increasing, decreasing or constant returns accordingly as the
marginal returns rise, fall or remain unchanged” as the quantity of a factor of production is increased.
In terms of cost, an industry is subject to increasing, decreasing or constant returns accordingly as
the marginal cost of production falls, rises or remains the same, respectively, with the expansion of
an industry

Chapter 15 Price: 2.99

In recent years, a new technique has been developed to study the theory of production and to show
the equilibrium of a producer regarding a combination of factors. This technique is of iso-product
curves which are parallel concepts to the indifference curves in the theory of consumption.
Just as an indifference curve represents various combinations of two goods which give a
consumer equal amount of satisfaction, similarly an iso-product curve also shows all possible
combinations of the two inputs physically capable of producing a given level of output.

Chapter 16 Price: 2.99

The cost of production of an individual firm operating in a market has an important influence on the
market supply of a commodity. It is very necessary to have a clear idea about the concept of cost of
production and then proceed to study the cost curves.

Chapter 17 Price: 2.99

Supply means the amount offered for sale at a given price. “We may define supply as a schedule of
the amount of goods that would be offered for sale at all possible prices at anyone instant of time, or
during anyone period of time, for example, a day, a week and so on, in which the conditions of supply
remain the same.”
(Meyers)
Supply should be carefully distinguished from stock. Stock is the total volume of a commodity
which can be brought into the market for sale at a short notice and supply means the quantity which
is actually brought in the market. For perishable commodities, like fish and fruits, supply and stock
are the same because whatever is in stock must be disposed. The commodities, which are not
perishable, can be held back, if prices are not favourable. If the price is high, larger quantities are
offered by the sellers from their stock. And if the price is low, only small quantities are brought out
for sale. In short, stock is potential supply.

Chapter 18 Price: 2.99

The father of economics Adam Smith in his book ‘The Theory of Moral Sentiments’ (1759), wrote
about the main characteristics of human beings. According to him a human being is very selfish or
posseses self-love as well as there exists an invisible hand. The concept of self-love in human being
is one of the most important factor in “the value theory” as well as in the development of market.

Chapter 19 Price: 2.99

Average revenue is the revenue per unit of the commodity sold. It is found by dividing total revenue
by the number of units sold. But since different units of a commodity are sold at the same price, in the
market, average revenue equals price at which the commodity is sold. Thus, average revenue means
price. Since the consumer’s demand curve is a graphic relation between price and the amount
demanded, it also represents the average revenue or price at which the various amounts of a commodity
are sold, because the price offered by the buyer is the revenue from the seller’s point of view.
Therefore, average revenue (AR) curve of the firm is really the same thing as demand curve of the
consumer.

Chapter 20 Price: 2.99

A firm is said to be in equilibrium when it has no incentive either to expand or to contract its output.
A firm would not like to change its level of output only when its total profits are the maximum. A
rational entrepreneur will expand output if he thinks he can increase his total profits by doing so, and
likewise, he will contract his output if he thinks he can avoid losses and thus increase his total profits.
Therefore, a firm is in equilibrium position when it is earning maximum money profits.

Chapter 21 Price: 2.99

Macro economics deals with the broad national aggregates like national income, national product,
employment, consumption, investment, money supply, government budget, balance of payment etc.
Of all these macro aggregates, national income and national product are the most significant
aggregates. National income is considered as the most comprehensive measure of level of economic
activity and index of economic growth of an economy. An understanding of the concept and
measurement of national income is, therefore, essential in the study of macro-economics. This is
what we propose to do in this and the following chapters. We begin this chapter by explaining the
concept of national income in general. Secondly, we take up the circular flow of income to show how
different sectors of the economic system are interrelated.

Chapter 22 Price: 2.99

In an economy producers produce a large variety of goods and services for the satisfaction of human
wants. The goods and services produced are so varied that it is desirable to classify them into some
convenient groups so that they are easily understood. We explain here the nature of goods and
services produced by grouping them into various categories in terms of their end-use.

Chapter 23 Price: 2.99

National income is often considered as the most comprehensive measure of how well the economy
is performing. It is necessary and important, therefore, to measure national income of a country so
as to have an idea of the performance of the economy. Measuring national income is an extremely
complicated and gigantic task. However, economists have devised various ways of estimating national
income. In fact, national income estimates are made in every country these days. In India, the task
estimating national income is entrusted with the Central Statistic Organization (C.S.O.), a department
of Ministry of Planning and Programme implementation. In this chapter, we examine how economists
measure a country’s national income that is generated from production.
While measuring national income it is important to keep in mind that national
income is taken in the sense of ‘net national
product at factor cost. However, while estimating NNP
FC we would first be required to estimate the gross domestic product (GDP).

Chapter 24 Price: 2.99

Inflation is a global phenomenon in present day times. There is hardly any country in the world today
which is not afflicted by the specter of inflation. It is on account of this that the phenomenon of
inflation has widely attracted the attention of the economists the world over, but despite that there is
no generally accepted definition of the term ‘inflation’ as it is a highly controversial term which has
undergone modifications. Different economists have offered different definitions of inflation. In fact,
there is a plethora of definitions on the subject. The layman, however, understands by the term
‘inflation’ a sizeable and a rapid increase in the general price level. Inflation in the popular mind is
generally associated with rapidly rising prices which cause a decline in the purchasing power of
money.